Greetings from the Money Show! While I’ve been meeting many of you at presentations and booth times here in Orlando, earnings reports have been coming thick and fast. And the S&P 500 is consolidating at high levels in preparation for an assault on the all-time highs of March 2000. As I said last week, the biggest story of the next five to ten years — and maybe of our whole investment lifetimes, making the dot-com mania look like a blip — is going to be the accelerating decline in the value of the dollar. You simply must reposition all of your assets to benefit from this, especially avoiding areas that will be badly hurt by the falling buck.
Stocks in general will benefit from a weaker dollar, especially high-growth stocks that do a lot of business overseas. So, before we get to this week’s earnings reports, I want to review the industry that drives the whole electronics revolution underlying the Content on Demand MegaShift, and recommend the biggest, best and cheapest stock in the group.
Back to Basics: The Semiconductor Industry
Moore’s Law, named after Gordon Moore, a founder of Intel, says that the number of transistors that can be put on a square inch of silicon will double every 18 months. It costs about the same amount of money to process that silicon, no matter how many transistors are on it. So the implications of Moore’s Law are:
- Computing power or memory per square inch of silicon will double every 18 months.
- The cost of computing or memory will fall 50% every 18 months.
Last week, I talked about the Intel and IBM breakthroughs in high-k metal gate transistor technology that will help keep Moore’s Law alive for at least the next 15 years. By 2020, the average $1,000 multimedia personal computer will have the brainpower of a human being. Everyone will have a 24/7 personal assistant, attuned to exactly what they need to work more effectively, research, interact and play. The opportunities that are coming to invest in companies riding this wave will make the last 30 years just look like fooling around. In the semiconductor life cycle as a driver of economic growth and fortune building, we are about where the automobile was in 1918. The Model T brought motorized transportation to the masses, and although it required learning a lot of new things and broke a lot, you could fix most of the problems yourself — and you were expected to. Sound familiar?
The steam engine in 1750 had a dramatic impact on the agricultural economy, and created the Industrial Revolution. The automobile in 1898 had a dramatic impact on the industrial economy, and created the mass production, middle class consumer economy. The semiconductor in 1952 has been having a dramatic impact on the mass production economy and creating a world-wide technology economy. But the speed of change, driven by Moore’s Law, is far higher than those two earlier revolutions. Every year, technology products become a higher and higher percentage of the world’s GDP. And every year, semiconductors have a higher and higher percentage of the content in both technology products and the older products of the mass production economy (think washing machines and cars), and the even older products of the industrial economy (think robotic assembly).
As you can see, the semiconductor is still at the core of the technology economy revolution. Someday, it will be replaced by DNA and genomics, but as Intel and IBM made abundantly clear, “someday” means sometime after 2020. Semiconductor sales were up 8.9% last year to a new all-time record of $247.7 billion, well ahead of my expectations. They will be up again this year, climbing about 7% to $267.5 billion. The Content of Demand MegaShift is driving a lot of this demand, but we also see strong chip sales to the Security MegaShift, the Video iPod MegaShift and the WiMAX MegaShift. And there are also semiconductor sales in many technology advances in MegaShifts that you might not first think of, like Biotech, New Energy Technology, New World Economy and Nanotech & New Materials.
Buy Intel LEAPs
The semiconductor business is strong, so I want you to have more exposure to it. Happily, we can do that best by getting back into the biggest semiconductor company of all, Intel (INTC). The stock performed poorly after we sold it last year, and their weak guidance for the March quarter knocked it down again. But with Windows Vista now shipping to both businesses and consumers, I expect Intel to have a strong second half in 2007 that will extend through 2008 into 2009. Love it or hate it, Windows Vista is going to succeed and drive a major PC upgrade in corporate America over the next three years. The new security features really do work, and while using the words “security” and “Microsoft” in the same sentence usually causes a snicker, Microsoft has an enormous amount of resources focused on this program. One nefarious reason for the expected strength in Windows Vista sales is that Microsoft can use security as the reason for integrating new applications and thwarting the antitrust forces in Europe and the U.S.
Everyone knows Intel will have a seasonally weak March quarter. They’ll report 22 cents or 23 cents a share, about flat with last year’s 23 cents. But I expect their guidance for June to be a bit above expectations, and with the S&P about to head for new all-time highs, institutional money should pour into this stock for the rest of the year. I think Intel will earn $1.15 a share this year, a bit above the consensus of $1.09 and well ahead of the 86 cents that they reported in 2006. In 2008 they should hit $1.50 to $1.60 a share as Windows Vista-based PCs ship in large quantities.
INTC has been trapped under $22 for quite a while, but I think it can break through this barrier, with the help of Windows Vista. My target price for INTC is $35, which I expect sometime in 2008. You may just want to buy the stock under $22 and hold it for a 59% return over the next two years, but I am always trying to find you doubles that will qualify for long-term capital gains tax treatment. So, I want you to buy the January 2009 LEAP calls with a $22.50 strike price (VNLAX) under $3.50. The target price is $12.50 at expiration, a 250% return. This is most definitely a Top Buy. I am going to follow this position in the Content of Demand MegaShift, because that is the biggest current driver of semiconductor sales.
Before we wrap up our Intel discussion and take a look at our MegaShifts and current holdings, I had a question about Intel from subscriber Louis. He asked: “Is the chip Intel announced last Friday and talked about in your commentary today the same technology they bought the rights to use from Energy Conversion Devices (ENER)”
No, it’s not. The Ovonic technology is for memory chips, not processors. I think Intel is interested in using that technology to re-enter the memory business at some point. Intel used to make DRAM and still makes one type of flash memory, and has always been interested in that market, although they don’t talk a lot about it. Anything they do with the ENER technology will be additive to my earnings estimates above and just drive the stock higher by the time the LEAPs expire in 2009.
Avian Flu MegaShift
BioCryst (BCRX) reported a smaller than expected loss of 34 cents a share on $2.1 million in revenues. They spent $11.2 million on R&D in the quarter, compared to $6 million last year, due to the expanded peramivir and Fodosine clinical programs.
As usual with a development-stage company, the numbers matter less than the business fundamentals. Here, the news was good. In January, Phase II trials started for both Fodosine (a pivitol Phase IIb trial for relapsed T-cell leukemia/lymphoma) and peramivir (intramuscular dose for seasonal flu). BioCryst signed a deal with Mindpharma to develop and sell Fodosine in oncology markets in Europe, Asia and Australia. The new CEO was very upbeat for clinical progress in 2007, and, of course, we should get results for peramivir against avian flu around midyear. BCRX remains a Top Buy all the way up to $19 for my $30 target.
Biotech MegaShift
Affymetrix (AFFX) reported this morning, beating estimates and guiding at or a little above the consensus for 2007, and the stock closed up $1.14 for the day. Earnings fell to 13 cents from last year’s 43 cents, while revenues hit $104.2 million. They said that analyst estimates for 2007 are “reasonable” but added that gross profit margins should return to the mid-60% level by the end of the year. That is higher than most analyst estimates I’ve seen, and was one of the factors that caused Caris & Co. to upgrade the stock today to above average.
As I’ve mentioned before, AFFX just started shipping the new Genome Wide 5.0 Array in limited quantities in December, and this is going to be a big product this year. I’m raising the buy limit on AFFX $2 to $26, just in case you can get it in a market decline, while keeping my target at $40 for now.
Dendreon (DNDN), as I’ve mentioned before, might sign a marketing partnership even before Provenge gets FDA approval on May 15, and Kenny asked: “Which company best suits their needs? Which company do you think will ink a marketing deal with DNDN?”
Any big pharma with an interest in oncology would be very interested in a new, novel cancer technology that will spin out many more drugs against other forms of cancer. Any big pharma currently in prostate cancer would definitely be interested in a new prostrate drug. My best guess would be Pfizer, but Merck, Lilly or Novartis are other highly-likely partners. Bristol-Myers would also be on the list, but they may be about to be acquired, which could slow down talks. Continue to buy DNDN under $7 for my $14 target, which will occur either when a partnership is inked or the FDA approves Provenge.
Content on Demand
Harmonic (HLIT) reported a good quarter, which I covered last week. This week, Cisco reported, and the CEO was more optimistic than he’s been since 2000. He actually used the phrase “killer application” to describe video, and he’s usually a pretty calm guy. I also mentioned last week that Comcast (CMCSA) had a good quarter but “disappointed” Wall Street by raising their capital spending budget for 2007 to $5.7 billion, up from $4.6 billion in 2006. The reason for the increase is because cable companies have to spend a ton of money improving and expanding their systems, or they will lose video customers to the telephone companies that are now deploying fiber to the home. Because TV is the core of any cable system, with Internet access and voice just profitable add-ons, the industry has no choice but to follow Comcast.
One easy way to upgrade a cable system is to increase the number of segmentable nodes. For example, if an optical fiber is running to a neighborhood of 500 homes, where it terminates in a box (node) that then sends the signal over coaxial cable to the homes, that node can be split into two or four nodes. Each node in a two-way split only has to support 250 homes; in a four-way split, 125 homes. As video downloads, Internet traffic and voice customer hours increase, the service won’t degrade if the nodes are split.
Harmonic’s products are designed to upgrade with a simple plug-in circuit board. Some of the competitors require a “forklift upgrade” in which the old box is completely replaced with a new box. Because the cable companies know they will be splitting and resplitting nodes in the future, until they too finally have fiber to the home for all their customers, Harmonic has a tremendous advantage in selling equipment in this new, multi-service environment. Incidentally, Comcast is one of Harmonic’s largest customers. HLIT remains a Top Buy on any dips under my new $9 buy limit for the new $16 target.
Silicon Image (SIMG) reports this afternoon. I am looking for above-consensus results: $79 million in sales and 28 cents per share, but their take on the HDMI market for the rest of the year will be the key to the stock. Consumer electronics are seasonally weaker in the March quarter, so I don’t think their short-term guidance will make a lot of difference. I expect them to guide for $71 million to $73 million in sales and 13 cents to 15 cents a share in the March quarter. As always, I will send you a Flash Alert if needed. Buy SIMG under $13 for a $20 target.
Zhone (ZHNE) reported the other week, and I said that I would update you after the conference call, but didn’t get it in last week. As Ary asked: “Last week you said you would update us on Zhone this week after listening to the conference call. What happened?”
Well, not much. December-quarter sales were $44.3 million, not much better than the September quarter’s $43.1 million and still well off last year’s $53.2 million. EBITDA (earnings before interest, taxes, depreciation, amortization and, in Zhone’s case, stock-based compensation) improved to a loss of $2.3 million from a loss of $5.1 million in the September quarter. However, pro forma EBITDA was positive in the same quarter last year at $1.1 million. So, there was nothing for Wall Street to get excited about here. The company guided for March-quarter revenues to be slightly lower at $40 million to $42 million due to the usual seasonal weakness, but that was already in the valuation.
The bright spot is their next-generation products for DSL, which pushed revenues from SLMS (single line, multi-service) up 11%. I am keeping ZHNE on the buy list with the same $2 buy limit and $5 target, but removing it from the Top Buy list. It will take the company some time to get their overall revenues growing again, as legacy product sales decline and new SLMS product sales grow. When they finally do report a good growth quarter, the stock will jump, but we’ll still be able to get into it under $2.
One reason I am keeping it on the buy list is that ZHNE is a prime target for a buyout or to be taken private, and that would happen at $4 or $5 a share. I think it is obvious that Mory Ejabat would like to make it a stock market success in its current incarnation, but the venture capitalists and leveraged buyout firms that founded the company may have other ideas.
New Economy MegaShift
Omniture (OMTR) reported after the close today. I expected them to beat the consensus of a penny a share, and they did two cents per share pro forma on record revenues of $23.5 million. They added over 250 customers in the quarter, bringing them to 1,800, and processed 420 billion transactions.
However, they guided for revenues of $26 million to $27 million in the March quarter, with earnings of zero to one cent a share. The Street consensus was two cents. Further, Omniture guided the yearly estimate to $128 million to $130 million in sales, with pro forma profits of seven cents to nine cents a share. But the Street consensus was 17 cents. So, the stock dropped $1.50 in aftermarket trading on this guidance.
I haven’t had a chance to listen to the conference call, but I think that it will be really interesting, as I think a number of big companies feel like their website was overwhelmed or not competitive during the holiday season, and Omniture’s pipeline of new clients will cause them to have a very positive conference call. I may well raise the buy limit on OMTR after I hear the conference call, and if so I will send a Flash Alert tomorrow. For now, OMTR remains a buy under $10 for my $20 target.
New Energy Technology MegaShift
Rentech (RTK) drew a question from Jonathan: “Michael: Does their CTL process remove sulphur and mercury? Does the process reduce carbon emissions? Coal is cheap and plentiful but faces a lot of hurdles unless it can deal with these issues.”
You bet! Virtually all of RTK’s patents deal with controlling the pollution from the Fischer-Tropsch process, as opposed to improving the basic process. Rentech realized early on that if they could develop a near-zero emissions process, it would be acceptable in the U.S. and give them a strong market differentiation from Sasol, the industry leader based in South Africa. Coal-to-oil in Germany during World War II and South Africa during apartheid was a political necessity, and damn the pollution. In China, it is an economic necessity, and while they are uncomfortable with the pollution, growth came first. But in the U.S., Rentech had to get it to near-zero emissions to attract the interest of the coal companies, which they now have done — Willams, Peabody and Arch are on board. I think this technology is a lay-up for widespread adoption because it provides value-added for the coal companies and makes them environmental good guys — an unaccustomed position for them. RTK is a Top Buy under $5 for my $11 target, and I expect it to turn into a multiyear holding for much higher prices.
Royal Dutch Shell (RDS.A) reported record annual profits at the end of last week, but forecast lower refining margins due to the lower price of oil, higher costs and lower growth targets. However, they also announced a big stock buyback, which they can easily fund from their record cash flow, and the stock went up after the conference call.
Because I am convinced oil prices will go up as the Fed and central banks around the world keep printing money, which also means growth will be OK in the U.S. and double digits in China and India, I am not concerned about their forecast based on the current price of oil. I did like the expanded share buyback, and you can still buy RDS.A on any dip under $66 for my $75 target.
WiMAX MegaShift
Alvarion (ALVR) reported this morning, and the stock is up after they showed strong momentum in WiMAX. The numbers were a bit confusing due to a loss of $4.5 million in discontinued operations, namely the Cellular Mobile Unit. But they broke even from continuing operations and reported three cents a share pro forma, beating the Street consensus by a penny.
More important, ALVR built on good news earlier this week by showing $24 million in BreezeMax sales in the quarter, almost reaching their goal of exiting 2006 with half their revenues from WiMAX equipment. BreezeMax accounted for all the growth in continuing operations in the quarter, with sales up 40% from the September quarter and up 140% for the year to $72 million. That was 40% of their sales for the year, and it is obvious WiMAX equipment will be well above half of this year’s sales.
What I really like about ALVR is that they have managed to get profitable on current operations even after funding very high R&D investments in mobile WiMAX. They already would be at 10% pro forma operating profit margins, if it were not for the mobile WiMAX program. This gives them a chance to be well ahead of their competitors, and they are now winning back contracts that initially went to competitors who could not deliver on their promises.
Earlier in the week, ALVR won a big contract from Chungwa Telecom, the leading telecom company in Taiwan, to install a BreezeMax system in central Taiwan, which includes a very mountainous area. WiFi hotspots will feed data into the BreezeMax system, as well as directly-connected customers.
The company guided above consensus for $49 million to $53 million in sales in the March quarter ($50 million consensus), and one to four cents a share earnings (one cent consensus). They are targeting 15% to 20% revenue growth for the year, composed of 50% growth in WiMAX and flat non-WiMAX sales. They expect gross profit margins in the high 40% area, a bit above their long-term goal of 45%.
Alvarion had 140 WiMAX deployments in 2006, more than any other vendor, and they are in more than 200 trials right now, again more than any other vendor. They are driving the OPEN WiMAX standard, designed to be sure customers can plug-and-play WiMAX gear from any vendor in their systems. They’ll be making a major push in this area at the big 3GSM conference in Spain next week. (GSM is the most popular cellular standard in Europe.)
ALVR has the only commercially viable mobile WiMAX system on the market right now, but without many handset suppliers and the ability to plug-and-play equipment from other vendors, it isn’t a practical decisions for larger carriers yet. What is really resonating with customers is the ability to deploy an initial fixed WiMAX system that can generate revenues now, and then be expanded to mobile WiMAX later. A lot of the trials in the U.S. and Asia, some with Tier 1 carriers, are based on this product roadmap.
As I said two weeks ago, I was very surprised to see another newsletter switch their subscribers from ALVR to Airspan (AIRN), in advance of this week’s good news. I was very happy with the conference call, and the stock is up about 11% this week as the Israeli stock market hits new records. I still want to own AIRN and Terabeam (TRBM), as well as ALVR, but the truth is that Alvarion is the leader and ALVR remains a Top Buy under $9 for my $18 target. That’s just the first target, and I expect this to be another multiyear holding.
Market Outlook
The S&P 500 is consolidating above the crucial 1440 level that it broke through last week. As early as tomorrow, I’m expecting a strong run to begin towards the all-time high set in March 2000 at 1552.87. You should be fully invested for this move.
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